Passive Investors Are Trend Followers

Passive investors in equities are trend followers who do not try to minimize drawdowns with tactical models.

In the realm of investing, the majority of concepts are based on convention, much like in science. Objectivity about definitions and rules is more of a matter of convention than a law of reality.

Henri Poincaré (29 April 1854 – 17 July 1912) was a French physicist, mathematician, and philosopher, also known as a polymath, who made many valuable contributions to science. Two of the most important were chaos theory and topology. He was also a proponent of conventionalism. He believed that even laws, such as Newton’s, were suitable conventions based on assumptions.

Although academia and practitioners have proposed laws in finance and trading, as it turns out, much is a matter of convention. For instance, attempts have been made to distinguish between passive investing and market timing, yet no universal rule exists to permit this. In fact, we can consider a passive investor in the stock market a trend-follower who is not interested in tactical models and limiting drawdowns. How people define the difference is a matter of convention, and these conventions may vary according to perceptions and objectives.

Someone asserted that subtracting the beta performance—in this case, the buy-and-hold performance of the passively held IVV ETF—should adjust the performance of RSST. However, note that the post referred to managed futures and trend-following ETFs. In the case of RSST, we can assume that the passive investment in IVV is the result of a trend-following model with an extra slow moving average, such as a 60-, 120-, or even 240-month moving average, which will almost never trigger a switch.

This is not a trick designed to impose conventionality and avoid adjusting the RSST performance by subtracting the IVV buy and hold performance.

Passive investors essentially follow trends, as they only make long-term investments in a market if they believe the trend will continue upward. Therefore, in the case of passive investing, theoretically, the period of the moving average is infinite, but in practice it is finite, because at some point even passive investors exit the market. In fact, passive investing is a limiting case of long-only trend-following. Although passive investors follow trends, they do not prioritize minimizing drawdowns and beta. Instead, they often view market corrections as an opportunity to average down. This reinforces the notion that some passive investors belong to a different class of market timers.

In conclusion, conventions have a significant influence on the fields of finance, investing, and trading. Some people refer to passive investors as unsophisticated, but this may be far from the truth. Some other people think that trend-following means making frequent adjustments to exposure, but in some cases it may take decades, and the process could still be tactical.

Having an open mind about finance, investing, and trading could open new avenues and improve performance. Often this is difficult because various actors attempt to enforce conventions that suit them, but as soon as one realizes that those are simply definitions, new possibilities could emerge.